One of the great uncertainties facing the global economy heading into 2010 concerned exit strategies. At what point was it safe for governments to begin unwinding the massive stimulus programs implemented to fight off the Great Recession? We always knew this was going to be a tricky question. Cut back too soon and sink the global economy into a “double-dip” recession; wait too long and run the risk of pumping up asset bubbles, inflation and government debt.
Unfortunately, jittery markets have answered this question for us, at least in part. In the wake of the Greek sovereign debt crisis, investor attention has been squarely focused on rising government debt and deficits throughout the developed world, putting pressure on policymakers to rein in fiscal spending no matter what underlying economic conditions they face. Governments are clearly getting ushered to the exits. A senior official in Spain told me that his government has had to accelerate budget cuts because of negative market sentiment. Spain’s economy, with 20% unemployment, is still expected to contract in 2010 and thus can’t afford further decreases in demand. But investors aren’t giving governments the time they need to adjust.
That has raised the scary question: Are we exiting from stimulus too soon? And will the new commitment to austerity imperil the global economic rebound?
Many highly regarded economists say yes, and are saying so very loudly. Stephen Gandel has already posted on Paul Krugman’s war on austerity, and Krugman has good company. Fellow Nobel laureate Joseph Stiglitz told Reuters a few days ago that growth will be “markedly lower” by the end of the year due to European budget cutting. He went on to say:
The problem is that we’re in, you might say, a vicious cycle. Austerity is going to lower growth. A weak euro and a weak Europe is going to be bad for the United States.
Yet not everyone agrees. Barclays Capital economist Simon Hayes argues that worries about fiscal retrenchment are overblown. The level of stimulus in 2010, he notes, is not being significantly reduced when examined on a global scale. Here’s what he wrote in a recent report:
Across the G20 as a whole, the estimated level of support in 2010 is similar to that seen in 2009, with a rise in the stimulus provided by developed economies (primarily the US) largely offsetting a reduction in stimulus by emerging markets. Thus, despite recent rhetorical emphasis, fiscal policy remains a significant support to demand at present, making consolidation more of an issue for 2011 and beyond.
Hayes goes on to say that the recovery is strong enough, and monetary policy loose enough, to overcome the potential drag from reduced fiscal stimulus:
In our assessment, there is sufficient momentum in global activity and sufficient flexibility on the part of policymakers worldwide for the global recovery to withstand more concerted fiscal tightening. To be sure, the global policy mix is likely to shift, with monetary policies kept looser for longer to facilitate tighter fiscal stances. Policy flexibility implies that precise paths for policy settings will remain difficult to predict, but we remain comfortable with our forecast that the global growth recovery will be sustained.
Hayes is getting at the heart of the matter. The timing of stimulus exits has always been dependent on private sector activity. It was time for governments to scale back once we were sure that a recovery in private investment and spending was strong enough to take the place of stimulus. Hayes thinks that’s happening, but not everybody does. Martin Wolf in the Financial Times questioned whether the private sector is ready to step up to the plate and fill in the hole left open by fiscal retrenchment.
In 2010, according to the International Monetary Fund’s latest forecasts, the private sectors of every large high-income country will run a huge excess of income over spending. This is forecast at 7.8 per cent of gross domestic product for these countries as a group, at 12.6 per cent for Japan, at 9.7 per cent for the UK, at 7.7 per cent for the US and at 6.8 per cent for the eurozone. What we are seeing, in short, is an epidemic of private sector frugality – just as many economic doctors recommended…So how quickly should deficits be eliminated? We must recognize the danger here: cutting public spending will not automatically raise private spending.
Wolf concludes that therefore we’re cutting fiscal budgets too quickly:
Yes, I understand that huge fiscal deficits make people nervous. I understand, too, the desire to make solvency credible. But following fiscal rules blindly, while ignoring what is going on in the private sector or in external balances, is a recipe for disappointment and political conflict. Fiscal stabilization that supports growth is welcome. Premature fiscal stabilization that undermines it is yet another folly.
I have to admit to being worried. We were supposed to have a “coordinated” global exit from stimulus measures, one that would bring balance to the effort to make sure we didn’t get nasty side effects or a “double-dip” recession. Instead we’re getting something like a rush for the exits – exactly what we wanted to avoid. In Europe, many major governments are cutting back (or planning to) at the same time, not just those economies considered troubled (Spain, Portugal) but also others that aren’t facing the same level of market scrutiny (France, Germany). The European Commission put renewed pressure on Spain, Portugal and other EU countries to reduce deficits. The cuts are taking place without full regard for the continued weaknesses of the economic rebound. And I can only assume that eventually countries elsewhere with large deficits (the U.S., Japan) will be forced to reduce deficits due to domestic or international pressure. The impact of this herd mentality could be an amplified hit to the global economy. IMF Managing Director Dominique Strauss-Kahn recently emphasized the need to distinguish between the needs of different economies when addressing fiscal deficits:
Fiscal sustainability is certainly an important aim that countries all around the world, not only in Europe, but including in Europe, have to take into account. But you have to differentiate those policies depending on the fiscal room that the different countries may have, and taking into account the balance between the fact that you have to go back on a sustainable track on the fiscal side and the fact that you need to maintain the highest possible level of growth. So it leads to different actions in different countries.
This isn’t happening. I don’t believe the austerity measures will send the global economy back into recession. I don’t believe they’re dramatic or drastic enough to inflict such damage, at least at this point. But I do fear that this mad rush for the fiscal exits will lead to an even more anemic, tepid recovery, with true healthy growth pushed off further into the future. That means continued high unemployment. And that’s not good for anybody.